Internal Rate of Return (IRR)

Definition

Purpose

IRR—along with payback and net present value—is one of three metrics commonly used to evaluate return on investment over multiple periods. An IRR will typically be compared to a firm’s hurdle rate. If IRR is higher than the hurdle rate, invest; if lower, pass. For instance, a company might decide to undertake only projects with a return greater than 12%.

Construction

Internal Rate of Return (%) = The discount rate for which the net present value is zero for a series of future cash flows after accounting for the initial investment

Note that IRR does not describe the magnitude of return; $1 on $10 is the same as $1 million on $10 million.